Kumiva involved a merger and acquisition scenario. An American subsidiary of a Canadian security and cash handling business called Garda USA, Inc. (Garda) sought to expand its operations in the United States. It targeted a company called ATI Systems International, Inc. (ATI), a private security and armored car company with large operations in the United States. While Garda was negotiating to acquire ATI, ATI was in the process of acquiring a smaller security and armored car company with a strong presence in New York City called CDC Systems Inc. (CDC).

After ATI acquired CDC, it signed a non-binding letter of intent with Garda under which ATI agreed that Garda would conduct due diligence before purchasing ATI. Garda proceeded to hire PricewaterhouseCoopers to conduct due diligence along with Garda’s chief financial officer and investment bankers.

The parties then had extensive discussions and negotiations during the due diligence period. The purchase price being discussed was several hundred million dollars and was based upon ATI’s anticipated EBITDA.

Garda accused ATI of fraudulently inducing it to raise its offer by misrepresenting to Garda that ATI was achieving significant savings by integrating CDC into its own operations, while minimizing the difficulties ATI was experiencing integrating CDC. Garda claimed that had it known of the extent of the difficulties ATI was experiencing with CDC, and the number of customers ATI lost due to these difficulties, Garda would have lowered its offer by an amount in the range of $36 million to $81 million.

ATI opposed Garda’s claims of fraud by relying upon a disclosure in the merger agreement that ATI’s integration of CDC involved “several start-up issues including deposits being misrouted, lost or delayed, which caused some financial losses and some potential lost business.” ATI also argued that Garda filed to establish damages.

The lower court, Commercial Division Justice Saliann Scarpulla, dismissed the fraudulent inducement claim, holding that, as a matter of law, Garda failed to show nonspeculative damages and that ATI’s disclosures precluded Garda from showing justifiable reliance. On appeal, the First Department affirmed in all respects.

Pecuniary Damages

First, the First Department noted that “New York courts for over one hundred years have differentiated between the damages recoverable for a breach of contract action and those recoverable for fraudulent inducement. While a plaintiff alleging breach of contract is entitled to damages restoring the full benefit of the bargain, a plaintiff alleging fraudulent inducement is limited to ‘out-of-pocket’ damages, which consists solely of the actual pecuniary loss directly caused by the fraudulent inducement.”

The First Department continued that out-of-pocket damages are calculated in three steps. First, the plaintiff must show the actual value of the consideration it received. Second, the plaintiff must prove that the defendant’s fraudulent inducement directly caused the plaintiff to agree to deliver consideration that was greater than the value of the received consideration. Third, the difference between the value of the received consideration and the delivered consideration constitutes the “out-of-pocket” damages.

The First Department observed that to show non-speculative damages, Garda was required to submit evidence establishing ATI’s actual value on the date of the execution of the merger agreement setting the purchase price for the company. Garda was also required to submit evidence that ATI’s misrepresentations directly caused Garda to agree to pay consideration to ATI that was greater than ATI’s actual value. It would be the difference between these two sums that would constitute Garda’s out-of-pocket damages. The Court ruled that Garda failed to come forward with such evidence.

The First Department faulted Garda in failing to conduct a formal valuation of ATI’s value on the merger date. Garda’s experts attempted to calculate the first step of the out-of-pocket damages analysis by assuming that the purchase price constituted ATI’s actual value. The Court rejected this attempt, ruling that the negotiated price cannot substitute for evidence of ATI’s actual value on the relevant date for purposes of a damages calculation. The Court noted that if ATI’s value were equal to or greater than the purchase price, Garda would not be entitled to damages for fraudulent inducement.

The Court also rejected Garda’s argument that it would have made a lower offer if ATI had not made any misrepresentations. The Court noted that Garda actually conceded that a formal valuation might well have shown that ATI was worth more than the actual purchase price, in which case Garda would not have suffered any pecuniary damages at all. The decision is worth reading and studying insofar as it offers an informative analysis of pecuniary loss arising in fraud cases.

Justifiable Reliance

Finally, the First Department also found that Garda had not established justifiable reliance. The Court found that while the merger agreement’s disclaimers were not sufficiently specific to preclude justifiable reliance, such reliance was not reasonable because ATI informed Garda about the issues and problems concerning the CDC acquisition. Since Garda received several indications that the integration was not going as smoothly as anticipated or reported, and in fact its due diligence firm warned that “it is too early to assess the effectiveness of the integration plan,” Garda had not proven justifiable reliance on alleged misrepresentations concerning the CDC acquisition.